IFAs Control £591m of Britain’s wealth

So runs the Citywire headline (Alex Steger on Jan 26, 2012 at 14:39)

This research is brought to us by Scorpio Partners; a research organisation whose website declares

A decade of experience in the wealth industry has left us with a clear contention: the wealthy are being let down. Many businesses court them, few understand them, fewer still are valued by them. Until now.

I suspect that most generators aren’t losing too much sleep about all this and certainly aren’t going to consider the research of Scorpio partners as their means of redemption; if they are being let down, it is because they are being told to hoard their money and not put it to good use. By “good use” I mean purposeful use, investments in things that bring genuine happiness to both the investor and those invested in. Wealth brings its own responsibilities.

“Control” of this wealth is a very important issue not just for the owners of the wealth but those who benefit from its use and responsible investment  is at the core of all fiduciary management.  Here is Alex Steger’s excellent article. Read it as if it was your wealth being talked about!

IFAs are a crucial part of the UK’s wealth management industry, controlling over a quarter of the assets it holds and employing just over a fifth of its workers, according to new research.

The research, by consultants Scorpio Partnership, showed that of the £2.2 trillion of assets managed by advisers, private banks, high street banks, and private client investment managers, IFAs advised on £591 billion.

This was second only, by sector, to private banks, which managed £886 billion, with high street banks responsible for £501 billion, and private client investment managers handling £217 billion.

The survey also showed that financial advisers servicing clients with between £100,000 and £1 million of assets typically enjoyed gross profit margins of up to 35%.

The UK wealth management industry employs 124,000 people, with the IFA sector accounting for the second most of any sector, with 22,611.

Only private banks employed more people than the IFA sector with 22,700. High street banks employed 20,000, and private client investment managers 17,900. Life companies employed 5,800 people and platforms 4,237.

The survey showed the UK’s wealth management industry generated 1% of GDP, employing 12.5% of financial services workers, and influencing the wealth of nearly 9% of the UK population.

Andrew Fisher, Towry chief executive, said the aim of the research had been to show the importance of wealth management to the UK economy.

‘The industry needs to communicate in concert. This initiative is aimed at determining the core value of the wealth management industry and clearly shows the important worth of wealth – both personal and corporate – to the wider future story for the UK economy,’ he said.

Andrew Fisher is a very influential man. He is one of the most influential IFAs in the UK and as he points out , IFAs control a very large amount of wealth. However, his arguments are circular. The value of the wealth management industry is not judged by the amount of wealth that industry generates for itself but by the value of the management of that wealth to the national interest.

The various tax shelters offered to wealthy people are not there to ensure that IFAs continue to generate 1% of Britain’s GDP but to ensure that the wealth they managed is directed towards worthwhile projects.

Rather like horse trainers who value themselves for their winners and forget that the horses are owned and their fees paid by enthusiasts, IFAs can be in danger of forgetting that the money they manage was generated by someone’s hard work and their endeavours are first  for their clients and not for the linings of their pockets.

I noticed a number of comments around this article (which can be read at ). They were from IFAs who managed their client’s money. These IFAs were embarrassed by the word “control” and in differing ways self-deprecating about their work.

From the limited experience  I have of having wealth managed, I reckon that I would rather engage with an adviser who put my interests first and talked to me of the value of my wealth in terms of what it could do for my and others happiness, than an adviser whose primary concern was to assert his own sense of importance.

So long as the “wealth industry” continues to parade it’s profitability rather than its utility and promote wealth management over wealth generation, it will, for all its boasting, get short shrift from people like me.

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Hunger is not a word you’d associate with actuaries.

One of our clients described the team working for her as “happy puppies” who approached the task of educating members with ” hunger“.

These are not words that exist in the actuarial lexicon! You do not read these words in business manuals! But I know just what she means.

I wrote a blog earlier in the year called Popcorn Pensions, it discussed a change in mindset in our work, a movement from telling our clients what they have to do to helping them achieve what they want to do.

Inspiring enthusiasm in people for  retirement planning is not easy and needs a few core ingredients. It needs an efficient pension plan that gives its participants confidence that saving is worthwhile. It needs available funds either from the employer or the employee and preferably from both. It also needs a genuine enthusiasm for pensions saving right through the process.

It’s that last bit that’s been missing. I’m not talking about beaming  photos on brochures , fancy websites or alluring TV adverts (though all these things help). More like I’m talking about the hunger of the pension professionals who advise companies on their retirement strategy.

I’d go so far as to say that part of the function of professional advisers is to recreate a passion for the job in their clients. It is in their interest to do so.

Unless we can educate employers and trustees of the massive opportunity they have to make a difference to their member’s retirement, we as consultants are failing in our duty. The “lock-down” mentality among those who simply regard pensions as “unwanted risk” is and will be self-fulfilling. It will kill pensions.

If we can educate employers and trustees, then we can help them to instill this enthusiasm and endeavour into their workforce. I have absolutely no doubt that staff who go to work with the intention of doing a great job with the certainty of a happy ever after will be more productive and more stable than a staff who have no long-term strategy and who go to work without purpose or conviction.

Our client seems to have been invigorated by dealing with us. Right the way through the organisation, in the HR and Finance functions, the pensions department , among the business heads, the unions and all levels of the workforce, we think we’ve made a difference.

And this is the really interesting thing. The enthusiasm we have found for the job, since our Popcorn Pension moment is infectious within our organisation. The enthusiasts have taken over the asylum and the things we wanted to happen with our client are happening in our company.

Enthusiasm is infectious. It may not sit within the actuarial lexicon but it should be.

What drives the enthusiasm? My answer, from observation, is the desire to teach, to educate, to help others to take control of their lives through sorting our their finances in their later years. This enthusiasm depends on advisers who believe they can make a difference working together with our clients and their members to make it happen.

Education is at the heart of the process but it is based on the principles of Popcorn Pensions – that is a hunger to help  people get what they want .

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I came across this on mallowstreet and thought it relevent to many of the discussions on this blog.

I’ve written about ethics and political philosophy all my working life, but until the last two years I did not write on trust. If anyone had asked me why I didn’t, I would probably have said that trust was important, but that it was a social attitude.  

My work was on basic philosophical and practical questions about justice.  I wrote about reason and action, principles and practices, duties and rights, but not about social attitudes. Trust, as I saw it, was mainly of interest to sociologists, journalists and pollsters: they ask regularly whom we trust.  Some of our answers  (lookat the MORI website, http://www.mori.com/polls/) show that many of us now claim not to trust various professions.

Yet I noticed that people often choose to rely on the very people whom they claimed not to trust.  They said they didn’t trust the food industry or the police, but they bought supermarket food and called the police when trouble threatened.   I began to see that there is a big gulf between saying we don’t  trust others and refusing to place trust, between (claimed) attitudes and action.   Bit by bit I concluded that the ‘crisis of trust’ that supposedly grips us is better described as an attitude, indeed a culture, of suspicion.   I then began to question the common assumption that the crisis of trust arises because others    untrustworthy.    I began to notice that there were lots of news
stories about breach of trust, especially about supposedly scandalous cases, but that there was surprisingly little systematic evidence of growing untrustworthiness.

Two years ago I was asked to give the Gifford Lectures in Edinburgh for 2001. I chose trust in medicine, science and biotechnology as my topic. These lectures are about to appear under the title Autonomy and Trust in
Bioethics (April 2002, Cambridge University |Press). When I finished writing I knew there was a lot more to be said about trust and mistrust.  I had come to think that our new culture of accountability, which is promoted as the way to reduce untrustworthiness and to secure ever more perfect control of institutional and professional performance, was taking us in the wrong direction.
So when the BBC approached me to see what I could offer for the Reith Lectures, I suggested that I could look more broadly at trust and accountability, particularly in the professions and the public sector. In the lectures I argue that having misdiagnosed what ails British society we are now busy prescribing copious draughts of the wrong medicine. We are imposing ever more stringent forms of control. We are requiring those in the public sector and the professions to account in excessive and sometimes irrelevant detail to regulators and inspectors, auditors and examiners. The very demands of accountability often make it harder for them to serve public.

Our revolution in accountability has not reduced attitudes of mistrust, but rather reinforced a culture of suspicion. Instead of working towards intelligent accountability based on good governance, independent
inspection and careful reporting, we are galloping towards central planning by performance indicators, reinforced by obsessions with blame and compensation. This is pretty miserable both for those who feel
suspicious and for those who are suspected of untrustworthy action – sometimes with little evidence.
In the Reith Lectures I outline a much more practical view of trust. The lectures are not about attitudes of trust, but about actively placing and refusing trust and the sorts of evidence we need if we are to place trust
well. Far from suggesting that we should trust blindly, I argue that we should place trust with care and discrimination, and that this means that we need to pay more attention to the accuracy of information provided to
the public.  

Placing trust well can never guarantee immunity from breaches of trust: life does not provide guarantees. There is no total answer to the old question ‘Who shall guard the guardians?’, and there is no way of eliminating all risk of disappointment. Nevertheless, many of us would agree with Samuel Johnson “it is better to be sometimes cheated than never to have trusted”.
If we are to reduce the culture of suspicion, many changes will be needed. We will need to give up childish fantasies that we can have total guarantees of others’ performance. We will need to free professionals and
the public service to serve the public. We will need to work towards more intelligent forms of accountability. We will need to rethink a media culture in which spreading suspicion has become a routine activity, and to
move towards a robust configuration of press freedom that is appropriate to twenty first century communications technology.

This won’t be easy. We have placed formidable obstacles in our own path: it is time to start removing them.

I shouldn’t jest.  “Infrastucture  for pensions” is a major policy initiative so I’ve been thinking of ”family silver” we still own that could be rebranded to deliver a gilts + income stream to our needy pension  trustees.

Here are my top 10 picks

1. The TARMAC M25; Tarmac laid it, widened it and relaid it. If you’d been laid as often as the M25, you’d want to conceive a private/public partnership (if not a civil wedding).
2. The RFU Channel; The Rugby Football Union is about the only organisation that can still use the word “English” without racist undertones. As most of the water in this country is owned by the French (oh and the Chinese), it seems right that we maintain our rights to the English Channel by aligning ourselves to the core values of the RFU (greed, incompetence and middle-class ineptitude). The RFUis a past master in charging a fortune for a load of old rope so I look forward to the blazers setting an exorbitant congestion charge for the straits of Dover (renamed the Twickenham turnstile).
3. The Church of Branson; We really do not sweat the commercial potential of the Church of England as we should. Richard Branson looks like Jesus and has a sharp eye for an income generating opportunity. Look out for the unleaded church with a polythene roof and leaded windows replaced by digitally projected images of the Virgin Richard . The COE Pension fund needs  divine intervention.
4. The Towers Watson Bridge; The fine consultancy Towers Watson is omnipresent in the pantheon of pension advisers in corporate Britain. The gatekeeper’s gatekeeper should be offered the opportunity to make central London a ”Tower’ed” community, the bridge needs to be down to those Chinese Junks .
5. The House of British Gas; apart from a measly income stream from hapless tourists, the House of Commons has been a drain on public coffers for many years. It is time it was sold to and re-branded by British Gas along with the House of Lords, Courts of Justice and most of SW1. Considerable hot air is generated by politicians and civil servants in pursuit of the maintenance of their privileged status as guardian and beneficiary of the guaranteed pension.This should be used in UK to provide the renewable energy that we pay British Gas and its parent Centrica to sell. It would be good to see Centrica’s guaranteed pension schemes kept afloat by Whitehall waffle.
6. Ecosse Diageo. Scotland needs to be floated off as soon as possible. The EU is the natural home for this basket case that is currently supported by Westminster taxes raised via the revenues from our fine banks (RBS and HBOS). Diageo make some of their money from highland malts and are past masters of re-branding. A new name, harping back to the “bel-alliance”, would surely hasten the de-merger of Scotland into the Euro zone albeit with a hefty section 75 debt. Scotland owes much to its whiskey makers and should think it a small favour to sell it’s identity and tax revenues to Diageo.
7. “Royal Mail Rail”- this catchy title is not as stupid as it sounds. In the past the Royal Mail and the nationalised railways were the subject of one of the most succesful robberies ever. Both have continued to drain the public and its Treasury  ever since. While transferring what’s left of the Rail Network into the Royal Mail’s pension scheme might still not plug the Royal Mail’s pension scheme deficit , it would provide some pleasing synergies.
8. The Isle of MAN GLG; The IOM ’s a nightmare to get to and  it is horrible when you arrive. Currently it is full of offshore insurance groups but the Manxmen also want an influx of Hedge Funds.  MAN GLG is a fine organisation , its revenues are derived from getting pension investment into hedge funds and it keeps many pension fund advisers in a job. We say get MAN GLG to manage the Isle of Man as a “safe haven for financial chicanery” . Their overseas institutions (who pay no UK tax anyway)  can pactice tax evasion , call it tax avoidance and MAN GLG can package a a slice  of the revenues as the gilt + income stream to small pension schemes.  Ringfencing such practices on Manx could create a new Alcatraz for arbitrageurs - we would happily see them staying out there in their retirement!
9. Monarch-e The budget airline need a corporate makeover, it really is a shoddy brand. What better way to realign its public persona than for it to purchase the Monarchy including the Crown Estates and the marketing rights to Princess Di and the (semi) live ones. While a reverse takeover of this size might look outlandish, the “e” tag should change your mind. We do not need a monarchy or any of their accoutrements. Buck Palace, Windsor Castle and Sandringham form the basis of a superior hotel chain while the Queen and her retinue can easily be virtualised (I follow the fake Queen on twitter). Monarch can vastly improve revenues from the Crown by digitalising it and in the process keep their pilots in the kind of pensions previously reserved for BA.
10. The RBS National Debt. While our national debt can hardly claim to be an asset, it’s management could offer a lucrative basis point opportunity and who better to hand it to , than its principal contributor, the Royal Bank of Scotland. Government economic policy is too important to be left to elected officials and besides, there is a serious conflict of interest in getting civil servants to have to work for their pensions. Let’s deal with that issue by giving all at the Treasury maxed out early retirement pensions without further delay. Hand over the national debt to RBS and keep bankers in Fred-like pensions for ever.

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The NAPF, as I’ve mentioned a few times on this blog, are a rather better trade body than you’d expect . Revitalised by Joanne Seagers and Dan Torjussen-Proctor they appear a more progressive member centric organisation than in years gone by.

Ambitiously, they have decided to take on the vested interests of the fund management industry and issue a consultation on “transparency of fund charges”.

Here are my thoughts , you may have your own.

I welcome this initiative from the NAPF and in particular the idea of an industry Summit on  fund charges. The Pension Regulator has determined “Value for Money” as one of the 6 key driver of DC outcomes, the question is not just whether there is value arising from fund management activities but what “money” is being paid by the DC account holder for the fund management.

As the NAPF’s paper of November 2011 makes clear, a member of a DC plan is unlikely to get a clear view of what he or she is paying, how the payments affect the outcome of their pension saving and whether this payment represents good value.

The NAPF have wisely decided not to discuss the “value” question and to concentrate on ways of “making pension charges clearer”.

I’m going to be polite and make the following observations and close with three recommendations that I reckon would make for the basis of an “Industry Code of Practice”.

Observations

 1.       DC outcomes are subject to the same influences whether arising from contract based or trust based pension saving vehicles. There is no    sense in having differing disclosures for each.

2.       Fund management charges form a part of the total charges levied on a member’s account but are rarely separately disclosed. There is only so much information a member can take in and charges should normally be expressed in total. Where a member wishes to find out in more detail how the charges split , the information should be accessible for instance through a hyperlink or in paper form through an appendix.

 3.       Members of Dc savings plans are not really concerned  about how the charges on the fund are sliced and diced, they are concerned as the paper confirms, at the total impact of charges, especially when they can see it properly explained. However , a statement of the impact of the charges is meaningless unless it can be benchmarked. You can dmeonstrate the impact of charges to those purchasing funds by using comparative charging structures to demonstrate their impact. 

For instance, in the table below we show how the reduction in yield decreasing from 1.0% pa to 0.55%, has the same  impact to a 30 year old (retiring at 65) as an increase of 2%pa of salary to the employer’s contribution rate.

 

 

 

 

	SMPI (1% expenses)			SMPI (0.55% expenses)			Current
Age band	TOTAL	EE	ER	TOTAL	EE	ER	TOTAL	EE	ER
Under 30	16.0%	6.5%	9.5%	14.0%	6.5%	7.5%	16.5%	5.3%	11.2%
30 – 39	21.5%	6.5%	15.0%	19.0%	6.5%	12.5%	16.5%	5.3%	11.2%
40 – 49	29.0%	6.5%	22.5%	25.5%	6.5%	19.0%	16.5%	5.3%	11.2%
Over 50	39.0%	6.5%	32.5%	34.5%	6.5%	28.0%	16.5%	5.3%	11.2%

 

 

My recommendations to the NAPF fall out of these three observations

 From observation one, our recommendation is that disclosures should be consistent across trust based and contract based plans. They should be expressed as the total charge including the fund expenses impacting the unit price and not expressed in the AMC.

From observation two, my recommendation is that the primary information should be simple with the breakdown of where the charges go being readily available for those who wish more information.

From observation three, my recommendation is that the charges be expressed in a relevant way. It may be relevant to express them in relation to the reduction in pension purchasing power they create, or in the reduction in the value of the employer contribution or it may be better to show how a lower charge improves matters. Simply stating charges as an AMC or TER or other such irrelevant measure is not good enough.

I have a fourth recommendation, arising from our thinking on the charging of “fund expenses both at the fund management level and at the policy level. Our recommendation is that fund expenses be quoted as part of the annual management charge and not in addition to it. Details on this obscure but important issue are found in the addendum to this document.

 

 

 

 

 

 

  Addendum

Fund managers have the right to pass on all manner of costs to their customers; these costs are levied as “fund expenses” and are not normally included in the quoted annual management charge. They are taken directly from the fund and their impact is felt in a reduction in the unit price which determines the eventual pay out.

These charges can be found in the published accounts of a fund and can make interesting reading. Typically the charges include the fund manager’s standard fee (which can be supplemented by performance related fees) but also auditor fees, registration fees and then the transaction costs which can include the costs of derivatives, commissions and other transactional expenses. Then of course there are further deductions relating to trading, most notably stamp duty and non-recoverable VAT.  

Taken together, these costs can add up to a substantial proportion of the total revenues generated by the fund. We have no evidence that these expenses are being badly managed and there is an incentive for managers to minimise the costs to accelerate performance. However, the complexity of the charges that can be levied as “fund expenses” gives scope for managers to pass on costs that should be borne by the manager. There is also scope for the practice of paying “soft commissions” where fund managers will use expensive services from third parties which are passed on as fund expenses and in return received subsidised goods and services such as software from the third party.

The complexity that exists within the accounting policies of individual funds is also prevalent in the policies of the insurers who wrap these funds within insurance and reinsurance agreements.

L&G have a clause in their policy (5.12) where they can charge anything they deem reasonable at their discretion (all charges, expenses, taxes, levies, regulatory fees, reinsurance premiums and other outgoings..).

Undoubtedly, many trustees of occupational pension schemes, faced with their bill for the PPF levy would wish for the sake of their scheme’s solvency that they could insert such a clause to offset their scheme liabilities in a similar way.

These costs are on top of the expenses already incurred by the fund manager. We should point out that both at the fund level and at the policy level, L &G and LGIM have an admirable record of not passing on costs that should reasonably be charged to their shareholder

As a general observation, the more active the fund management, the higher the level of the fund expenses and the greater the opportunity for obfuscation, bad practice and even fraud.

Conclusion

The opportunity for bad practice among managers, especially active managers with complex fee structures, makes the auditing of fund expenses problematic. If the quoted annual management charge to be levied by the manager was to include these expenses, as sometime happens, the incentive to keep costs to a minimum would be greatly increased.

So long as the only impact of these expenses is to dilute the return on the fund, the opportunity for poor cost containment or even fraud, will continue to exist.

If you depend on the value others see in you for your sel-worth, your life will be an emotional roller-coaster where every imagined slight can tip you into depression and supposed praise becomes the fuel to coast you back to the top of the roller.

The solace of religion is that it allows you to live neither for yourself or for others but for a being not of this world.This third way , especially when spiced with a heaven laden with virgins, is appealing to those for at the bottom of the pile who can imagine themselves equal in the eyes of the Lord, to those on top. It is also convenient for those on top as religion that preaches deferred gratification declares injustice as temporary and inconsequential compared with future gains.

Was it Bob Marley who wrote these lines?

You preacher man don’t tell me, heaven’s not on this earth

You aren’t happy and you don’t know – what life is really worth

Cos if you knew what life was worth- you’d look for it right here on earth

And now we’ve seen the light- we’re going to stand up for our rights.

I find myself spending a lot of my working life trying to please a disparate group of colleagues who have different measures by which they judge me. Even if I was to succeed with the majority, I would fall our with the rest so my pragmatic solution is to run a dashboard where I target 50% of my partners are happy  and less than a quarter are pissed off. The toxic 25% need to turnover and my second target is to make sure no partner is in the toxic quadrant for more than a couple of months. This is known as pragmatism.

I think this dashboard idea is jolly good. There are all kinds of measures that we can use to check how others see us, I think of obvious ones like google searches and Klout but there are other tangible statements open to me as I lead such an open life with so much of my thinking in the public domain. The numbers that read my blog, follow me on twitter, are linked in to me or join my pension play pen me valuable data on what I am doing that works or does not. They are not howevr a measure of my self-worth. My integrity is what I am not what I am doing.

What I am finding, and this may be connected to my having given up drinking alcohol and smoking cigarettes, is that I am less bothered at the moment by how others see me, than I have been for a long-time. This detachment from other’s opinion has, I believe, its foundation in a sense of personal self-worth which in turn is derived for a sense of purpose and achievement.

It is as close a definition as I can find to happiness.

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It is led by the Jackal – Simon Kew

4.   Our Drummer is the mighty TC Jefferson

5. Our axeman is the boy – Ben Mulroney

6. Our rhythm man is slowhand Mike Patti

7. Kitchen,Tapper and Eastwood do the backing vocals

9. O’Malley does Roy Orbison

10.  You can get all the bios on the band and more good stuff at

http://www.pensionsrocks.com/bands/2012/pensions-playpen.aspx

13. You can come and support us by buying a ticket. the procedes of which will go to the Pension Rocks III charities and to our nominated charity – St Francis Hospice (thanks Jeff Prestridge). Tickets are £30 (£20 on the door-except they’re all sold out!). Seriously, we’re asking for a voluntary £10 supplement cos we don’t get much sponsorship.

14.  Our opposition on the night are a bunch of no hopers from AJ Bell, LGIM, NEST, MHP Comms and Lorica.

Don’t watch them, watch us

We are the very geriatric sound

So if you come off Oxford St

And you’re beginning to feel the heat

Well listen buster- you’d bettter start to move your feet

Tothe whackest unsteady beat

Of Play Pen’s

Racket of the lambs….

15.       The evening will be hosted by the Pensions Monkey

16. Judges are @OvationChris @psafloyd  and the fragrant @Loueezal (all in the Play Pen)

17. You can join the Pension Play Pen by http://www.linkedin.com/myGroups?trk=hb_side_grps_top  this gets you priority tickets access.

18.   WE ARE THE PLAYPEN – THE FAMOUS PLAYPEN! 

19. We get sponsorship from the NAPF, Plenum Group, First Actuarial, Jackal Advisory for which we are extremely grateful.

20. If you are in a band called the Racket of the Lambs and are thinking of sueing us – sod off- The Jackal’s name – sue him.

Oh and Triangle Simon plays the Triangle

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Any suggestion that member protection be reduced causes concern among those whose job it is to protect member interests-trustees. However, as this brilliant discussion document from my friend and colleague Derek Benstead demonstrates, the consequences of over-regulated member protection are often unintended. Over regulation leading to too much member protection (here in the protection of guaranteed increases in retirement) can kill the golden goose leaving a “ perfect stadium with no one watching the game”.

Many trustees, union officials among them, understand this and recognise that just as DB can best be supported by easing the burden or retirement guarantees, so DC outcomes can best be improved by allowing DC to share in a managed drawdown from a collective fund – as DB pensions would become if the new Government thinking was adopted.

Derek’s comments are a critique of an argument put forward in 2009 by the then Government Actuary that what we today know as “collective DC” was prone to the same flaws as the recently discredited “with-profit annuity”. Derek comes at pensions from a very different angle than we are used to.  He genuinely understands the principle behind mutuality and he believes we can, as the Dutch have, employ to a system of not for profit pension provision based on a society that sorts its problems out for itself. Though his thinking is contrarian, it is expressed with such clarity, integrity  and vigour that I find it utterly compelling.

I include his arguments unexpurgated and without further comment –  for your edification and enjoyment.

 A discussion document on CDC

Equating non-commercial CDC schemes to commercial with profit funds is misguided. As a former Standard Life endowment policy holder I know how my maturity payment was much reduced by Standard Life’s overspend on maturities before mine. With profit payout overspends are decided by a board of directors most of whom are not actuaries and who are motivated by payout league tables and sales drives. But a CDC fund run by trustees on behalf of an employer who simply wants his staff to have pensions does not have such commercial pressures. Trustees seeking to fulfil their normal duty to be fair to all members should alert to intergenerational issues and the risk of overspending.

I have found the attached DWP summary paper of GAD’s CDC work. I can’t find a full GAD paper on the internet and I changed jobs in late 2009, so if I had a GAD paper it is likely I left it behind at my last job. However, there is some interesting material in the DWP’s summary paper.

First, the description of a CDC scheme on page 5 is on the whole a good definition. But in the rest of the paper it is clear that GAD’s modelling is of much narrower scope than the broad definition on page 5.  Several things suggest to me that GAD’s modelling was misguided.

One, on page 17, there is a sentence which says “An absence of new members coupled with poor investment returns can lead to a scheme failing, with some members (both active and deferred) being left with no assets at all.”  There is something very wrong with GAD’s modelling if the money is running out even while there are some non-pensioners left.  I could perhaps understand it if the money ran out because the last handful of pensioners lived unexpectedly long, but in practice I would expect a running down CDC scheme to fully annuitise sometime after there ceased to be any non-pensioners.  The modelled decision making must be very wrong.  The correct conclusion must surely be, not that CDC doesn’t work, but that GAD’s modelling doesn’t work.

On page 6, one of the listed characteristics of the model is “Both pensions and pension increases are reserved for on an estimated buyout basis”.  On page 7, another is “The CDC scheme is invested 100% in equities”.

Why is GAD reserving for CDC pensions on a buy out basis? The pensions in a CDC scheme should not be guaranteed so there should be nothing to reserve for on a buy out basis.  Second, the modelled scheme is invested in equities.  Buy out pricing, which is driven by bond yields (or swaps), tells us nothing about the income to be expected on the equities.  Managing pension awards in an equity invested CDC scheme by reference to the bond market is a nonsense: the state of the bond markets tells us nothing about the pension payments that can be afforded from equity income.  So while the DWP report is not detailed about the modelling GAD did, it is clear that it has not been done well.

An equity invested CDC scheme should be managed by estimating the expected future dividend income and future contributions, and balancing expected pension payments for past and future service to that.  Clearly whatever the GAD modelling was, they didn’t equate the expected income and outgo, and for that reason in some scenarios they ran out of money.

To construct an up to date example, suppose a CDC scheme has a pension increase policy before and after retirement of RPI + 1% per annum, say, and is wholly invested in UK equities.  It would have seen its dividend income fall by 27.5% in real terms over the period July 2008 to June 2010. That doesn’t mean the pension has to go down 27.5% overnight. A new increase policy of say RPI – 0.5% pa would be more than sufficient to adjust benefit payouts over the life of the scheme to match the reduced dividend income (if the average duration of liabilities is 20 years, then a 1.5% reduction in annual increases is a 30% saving). The unprecedentedly severe reduction in dividends we have seen recently is easily handled in a CDC scheme.

No doubt it will be very difficult to wean the DWP off their misguided ideas about member protection. I don’t find the “regulatory own funds” regime very helpful and CDC is a wider idea than RoF.  Yet the DWP seems to have reached a position in which they think CDC = RoF.

Something close to CDC could be achieved in the DB arena if only the DWP would remove statutory minimum pension increases in payment.  We could then have a DB career average scheme with entirely discretionary pre-retirement revaluation and post retirement increases.  A DB pension cannot be decreased so there is a benefit guarantee to be met and this design is not CDC.  However, even the recent economic difficulties need not come close to triggering a need to reduce a pension in this model, as my example shows. The only step needed to turn such a scheme into CDC is to permit pensions to go down if needs be.  

Considering member protection, the important point is that CDC is better than money purchase DC, not that it is worse than DB.  Of course CDC is worse for member protection than DB, CDC is DC after all.  The point to focus on is that the defined contributions paid into a trust will be spent on the members.  The promise is the contribution, not the benefit.  Whatever the benefit outcome is, for better or worse, it will be worth what was paid in, and the DWP agrees that the benefit outcomes in CDC will on average be bigger and less variable than in money purchase DC.

The DWP needs to realise that DB member protections only protect members if they are in DB schemes.  The ONS occupational pensions survey shows that the number of active members in private DB schemes open to new entrants is about 1.0m, down from nearer 6m in the mid 1990s.  Member protection is not a function of regulation alone. It is the product of regulation and employers’ willingness to provide DB schemes.  We are surely at a point that employers’ declining willingness to sponsor DB schemes has more than offset the effect of “member protecting” regulations, and increasing regulation now has the effect of reducing the number of open schemes and reducing the number of protected members.  I suggest we’re in the position where the arrow is on the graphical illustration below.

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The 22-year-old dancer told of her night helping passengers, staff and herself off the stricken Costa Concordia with a poise and understatement that suggests she has rather more strings to her bow than dancing in front of European cruisers –  if that’s what you call floating round the med in a town that sounds like a coffee shop.

I was particularly taken by the gag she had written as her farewell note to her Mum and Dad had she not survive. Apparently she had been parted from her luggage for a month after her flight out to the cruise. Her parting note would have read

Ironic that I am returning without the luggage

Tragic as the events on this boat are, the sinking of this Euro superliner on the very night of the downgrading of the Euro zone may be remembered more for the parallels between the two than for the human suffering involved.

Watch out for the jokes on “mock the week” and “have I got news” and remember we dissed them here first.

However, amidst all the recriminations that are bound to follow the massive ineptitude of those managing the boat’s navigation, Rose Metcalf will be remembered - at least on this blog - as a sound , witty and self-deprecating seafarer who put her passengers, fellow-staff and family first.

Rose Metcalf- we salute you! And here’s a rather more flattering photo of you than the one published in the Daily Mail this morning!

Update ***Update***Update***Update

Whooah! Now we discover Rose is a Dorset girl from Wimborne where my relations are the funeral directors (you can step down lads).

The fine rag “the Bournmouth Echo have celarly doorstepped Mr and Mrs Metcalf and got this great interview from their brave daughter.

“It was very dramatic,” Rose said.

“Men came down in harnesses and took us off.

“The worse thing was the thought of jumping into the cold water in the dark.”

All her personal possessions, including passport and money were left on board.

Rose called home at 3am on Saturday morning to tell her parents she was safe.

Dad Philip picked up Rose’s phone message a few seconds after she left it but had no way of getting back to her immediately.

Rose was having a coffee when she heard a loud bang and then the lights went out.

At first they were told it was an electrical fault.

Rose said: “It was about nine o’clock and I was in the restaurant having a cappuccino when there was a huge bang.

“Water started coming in and the lights went off and everybody was running around not knowing what to do.

“I was still in my dance clothes and I dashed off to my cabin where I had a hangar of dry clothes and I put them on with a life jacket.

“Then I had to go to a station point because I was staff. The ship was listing almost immediately.

“When I got to the station point they said it was an electrical problem and told me to go back and put my dress on, but I said no way.

“I then went off to help calm the passengers and helped do a roll call. People then started getting into the boats and by this time it was quite full of water.”

 

 

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Put the question “why are pensions guaranteed?” into google and you will not get an answer. I reckon it’s because no-one asks the question.

Why is nobody asking the question?

Is someone guaranteeing the value of your house?

Is there a guarantgee that your share portfolio won’t go down in value?

Are you guaranteed a job for life?

Of course not?  If you were guaranteed all that lot , so would everybody else and the cost would mean a communist state whee there was no incentive to get out of bed.

So what makes your retirement income any different?

Somebody has chosen that you needed those guarantees why?

Suppose we in the UK did what the Australians and Americans do and pay all the money you’ve buit up in your pension as a big lump into your bank account – would that be better?

What would you do then? Would you go out and blow the money, or sit on it  or invest it or would you buy yourself a guaranteed pension?  I suspect that most of us would not chose to buy ourselves a pension.

So when we get to retirment and go and buy a pension, we are doing something strange to us and we’re doing it because that’s what you have to do.

Almost all the problems we have in this country with pensions are created by the guarantees that are offered in retirement. Sure, from time to time, the marekts in which pensions are invested don’t give the expected returns but this is small beer compared with the problems created by pension promises.

The question is really relevent today as we are in a period of crisis created by the economic crisis. The low interest rates which we are enjoying as mortgage payers are crucifying the guaranteed rate at which insurance companies and company pension shcemes put aside money to cover the pension promises they are making. The cost of reserving is driving some companies offering staff guaranteed pensions out of business. For those of us who have to buy the guaranteed pensions ourselves (eg all of us in DC pensions), it’s us who will have to pay for these guarantees and we have to do so by taking less retirment income than we were expecting.

Now it may be that you are prepared to pay this price but it may be, when you are told that these guarantees are costing us a 30% cut in our retirement income, you may think again.

The 30% figure refers to the anouunt of pension that you can get by buying an annuity in the UK compared with how much pension you’d get from an equivalent Dutch pension which you can’t buy into (unless you live and work in Dutchland -sorry Netherlands/Holland whatever).

Now I’m led to believe that certain high-ranking pension people including the minister for pensions Steve Webb, have been looking into these Dutch pensions and have decided they are a little flakey for us in the UK. Why? Why- because the Dutch pension doesn#t have guarantees.

Let me provide you with a difficult choice.  I wll pay you £70 for certain for next five years – £350 in total. Or I will pay you £100 this year, £105 next year, £110 the year after, £115 the year after but only £100 in year five- that’s £530 altogether or £180 more overall. You’d take the £530 over £350 wouldn’t you?

You wouldn’t worry too much that your payment in the final year was £30 less than a year before.

Now I may exagerate a little -  ok a lot – but it’s for a reason. I would like you when you finish reading this to ask yourself just why we Steve Webb and the Government Actuary and the civil servants at the DWP are so worried about us adopting something like the Dutch system where we seem certain to get more money overall, albeit in a slightly less certain way.

Because the Government seem quite happy for us to have all kind of uncertainty about houses, jobs and not least the funds we build up in these DC pensions but they are adament that our pensions should never be allowed to go down.

This looks like something you should be looking into eh? Something worth asking some questions about? I don’t know the answer but I’m going to keep asking the question.